Inflation to rise rapidly but not unexpected

It is time for investors to position their portfolios for high inflation and allocate to value stocks by taking advantage of below-zero real interest rates to purchase real assets, according to Research Affiliates.

Chris Brightman, the firm’s chief executive and chief investment officer, the current inflation rate was not a surprise, as over the past two years, governments had embraced Modern Monetary Theory (MMT) to cushion the economic pain inflicted by the pandemic. Governments had also coordinated their fiscal and monetary policies to transfer newly-created money directly into bank accounts without raising tax receipts.

However, he argued that the situation at the start of 2022 was worse due to the huge deficits and massive debt accumulated in 2021.

“As I explained at the outset of the pandemic policy response, if money printing succeeds in maintaining the nominal value of consumption spending, many more dollars will be chasing a smaller amount of goods and services. The result is inflation,” he said.

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Additionally, he said inflation was a political poison because it eroded the real purchasing power of the income of the vast majority and sustained inflation may be the expedient political path to diminish the real value of excessive public debt.

Therefore, informed investors should reposition their portfolios by paring back positions in mainstream stocks and bonds, particularly interest rate–sensitive growth stocks, borrowing at long-term fixed rates, and diversifying into real assets such as real estate, commodities, and resource stocks.

“Without relying on aggressive valuation-reversion assumptions, we are forecasting value stocks to deliver long-term real returns exceeding 6% in the US market and in the 8%–10% range for the Japanese, European and emerging markets,” he said.

“Not only are the long-term return prospects of value stocks around the world attractive relative to the investment opportunity set, they offer exposure to the cyclical sectors of the economy that tend to benefit from reflation.

“Investors may also want to take advantage of below-zero real interest rates to finance purchases of real assets, whose prices tend to rise with inflation.”

Moreover, investors may wish to prepare for the possibility of liquidity shocks that may accompany central banks’ tapering of quantitative easing and the upcoming incremental increases in short-term interest rates by the Federal Reserve.